ROE (Return on Equity)
Return on equity (ROE) measures a company's net income as a percentage of shareholders' equity, showing how efficiently it uses owners' capital.
Return on equity tells you how much profit a company generates with the money its shareholders have invested and left in the business. The formula is net income divided by average shareholders' equity, expressed as a percentage.
Example: a company earns net income of $150 million and has average shareholders' equity of $1 billion. Its ROE is 15%.
A consistently high ROE can indicate a strong business with a competitive advantage. Comparing ROE within the same industry is more useful than across industries, because capital needs differ widely.
ROE has a catch: it can be boosted by debt. Because equity is assets minus liabilities, a company that borrows heavily or buys back lots of shares shrinks its equity, which raises ROE even if the business has not improved. A very high ROE should therefore be checked against the debt-to-equity ratio. If equity is negative, ROE is not meaningful.
The DuPont analysis breaks ROE into three parts, net profit margin, asset turnover and financial leverage, to show what is really driving it.
ROE is closely related to return on assets and return on invested capital.